Four keys that a lender takes into consideration when determining whether to extend credit to you.
A person who earns $1 million a year but has $2 million in debt is not necessarily a good credit risk. That’s why lenders look at your financial history in a number of ways. Think of these practices like those of a physician who takes many factors into account to determine your physical health. Here are some items your lender is considering about your financial health.
Credit score: Most people have heard of a credit score. There are several companies producing credit scores, but the most popular one is the FICO score. (FICO stands for Fair Isaac Corp., the company that first developed the score.) With one number, your credit score represents your creditworthiness. That simply means: What are your credit bills and do you pay them on time? You may be surprised that your credit score does not include your income as part of the calculation, just your credit and payment history.
Your credit score helps lenders determine their risk in loaning you money. Specifically, a credit score helps them determine who qualifies for credit, what the interest rate should be, and what the credit limits should be. As for the scores, most of the credit report ratings range from 300 to 850. Your ideal credit score would be at least 720 and no lower than 650. Just like altitude during an engine failure, higher is better!
DTI: Just like aviation has its own jargon and abbreviations, so does the world of finance. In this case DTI stands for debt-to-income ratio, and it’s an important factor when seeking a loan. Your DTI is the amount of money you owe in rent, mortgage, credit card payments, student loans, car loans, etc. in any given month. That number is divided by your gross monthly income (“gross” means your income before taxes are deducted) to determine your DTI. Typically groceries, gas, utilities, and other monthly expenses are not included when determining your DTI.
Since lenders believe your DTI is a good indicator of your ability to take on new debt, it makes sense to know yours. In order to calculate your DTI, add up those monthly payments as listed above and divide it by your gross monthly income. As a general rule of thumb, lenders like a DTI under 40 percent (including proposed aircraft loan). Of course, the lower your DTI, the better your chance of securing a loan. If simple math confounds you, don’t worry: Check online for DTI calculators, which are available for free.
Liquidity: When it comes to securing a loan, liquidity refers to how easily an individual can meet financial obligations with liquid assets (assets that can be quickly bought or sold without affecting the price).
Of course, cash is the most liquid of assets, followed by money market funds, checking accounts, and savings accounts. From a lender’s perspective all of these would be considered like cash. CDs, savings bonds, stocks, bonds, options, and commodities and other investments that can be sold through a brokerage account are considered marketable securities and slightly less liquid than cash. Illiquid (meaning non-liquid) assets would be items such as art collections or rare books, stamps, wine, jewelry, or coins. One of the more illiquid assets is real estate, either personal or investment property, since it could take weeks or months to convert a real estate asset into cash. The most illiquid asset would be business interests. Valuations are very complex and subjective, and in a distressed situation, it would take a long time to turn into cash at what would likely be a significant discount.
As you can imagine, you could be “rich” on paper by owning $1 million in artwork, but with no cash or marketable securities, you would have a hard time meeting your financial obligations and therefore be too risky for most lenders. What you need to know when contemplating an aircraft purchase is that a lender is typically going to want to see you have enough liquid assets to cover the down payment and six months of payments on your loan. If you are self-employed or have inconsistent income, that liquidity requirement would likely increase. That’s not to say exceptions can’t be made, however, cash is king!
Unsecured Debt: When debt is “unsecured,” it means that there is no property or equipment attached to a debt as collateral. For example, your mortgage is a secured debt in that if you don’t pay your mortgage, the bank can recoup its losses by seizing your house.
Since unsecured debt comes with greater risk to the lender, the interest rate is higher than for secured debt, resulting in more interest. If you have a lot of unsecured debt, you will have a high monthly interest expense, which impedes your ability to pay other bills such as your aircraft loan. Keep unsecured debt to a minimum, don’t live beyond your means through credit card charges.
Understanding your creditworthiness: These are the ideal characteristics for each of four different credit areas a lender will review. If you are at the limit in all categories, you can expect that it may be a challenge to get a loan approval, and the stronger you are in any of the categories the greater chances of getting the best options.
At AOPA Aviation Finance, we understand that securing an aircraft loan can be a daunting process. Our goal is to make it easier for our members to finance their airplanes. If you have any questions about the credit approval process or if you need assistance with understanding and analyzing your financial picture, let the experts help. Our experienced team of aviation-savvy loan experts are ready to discuss your unique situation.
Great advice. Great rates. All from helpful and responsive reps you can trust! Three good reasons to turn to AOPA Aviation Finance when you are buying an airplane. If you need a dependable source of financing with people who are on your side, just call 800.62.PLANE (800.627.5263) or click here to request a quote.